Transition risk refers to the potential financial risks that arise from the transition to a low-carbon and sustainable economy. It is primarily associated with the shift away from fossil fuels and the adoption of cleaner and more sustainable technologies and practices.

Key Matters and Considerations in ESG

Transition risk can manifest in various ways. One aspect is policy and regulatory risks, where changes in government policies and regulations aimed at reducing greenhouse gas emissions and promoting sustainable practices can impact certain industries and companies. For example, stricter emissions standards or carbon pricing mechanisms can affect the profitability and viability of businesses heavily reliant on fossil fuels.

Technological risks are another component of transition risk. As the world moves towards a greener economy, new technologies and innovations are emerging, disrupting traditional industries and business models. Companies that fail to adapt and embrace these new technologies may face obsolescence and financial losses.

Transition risk also encompasses market risks, such as changes in consumer preferences and demand for sustainable products and services. Companies that are slow to respond to evolving consumer expectations may face declining sales and market share.

Additionally, transition risk includes financial risks associated with stranded assets. Stranded assets refer to fossil fuel reserves that may become economically unviable or prohibited from being extracted due to climate change policies and regulations. Companies heavily invested in such assets may face significant losses if these reserves are devalued or become stranded.

Investors and financial institutions are increasingly recognizing transition risk as a material consideration in their decision-making processes. They assess and manage these risks by integrating environmental, social, and governance (ESG) factors into their investment strategies, conducting scenario analysis, stress testing, and engaging with companies to encourage sustainable practices and disclosure.

By understanding and managing transition risk, investors and businesses can mitigate potential financial losses, identify opportunities in the transition to a low-carbon economy, and contribute to a more sustainable future.